Owning a small business is difficult. A business owner wears a lot of hats. They are the HR Department, the head of advertising and marketing, chief of operations, and Chief Financial Officer. Despite the fact that they are not a professional in all of these fields, the IRS expects them to know the law. They can be assessed large penalties for an honest mistake.
I tend to see three mistakes crop up time and again when working with small business owners – tax mistakes that can get you audited in a hurry. These mistakes are costly and can be avoided.
1. Classifying Workers as Subcontractors
The IRS has gotten very strict with this. If someone works for you tell them WHAT to do as well as HOW to do it, they are generally considered employees. As such, they should have payroll taxes withheld and a W2 issued at year end.
Independent contractors are workers with whom you have a written or oral agreement. You direct their work, but only in so far as shaping the end result. You do not control the means by which they get there. Independent contractors tend to supply their own tools and supplies. They do not receive employee benefits like a pension plan, insurance, and vacation pay.
Independent contractors should NOT be classified as employees. They should not have payroll taxes withheld and they should not be issued a W2 at year end. They should get a different tax form, a 1099.
The IRS and many states pay close attention to companies that classify workers as contractors. You should never deliberately try to classify a worker as something he or she is not. If you’re unsure, consult a tax accountant.
2. Using the Company Bank Account as Your Personal Piggy Bank
Often times business owners pay personal expenses through their company’s bank account. This is a bad habit, and in the case of corporations, can cause many problems.
A corporation is a separate and distinct entity. When an owner writes personal expenses through the corporate account there are a host of problems that will occur including the potential to pierce the corporate veil. You could become personally liable for transactions and could get assessed additional taxes and penalties as a result of this action.
3. Not Paying Payroll Taxes on Time
The IRS has a short fuse when it comes to paying payroll taxes. Since payroll taxes are mostly from employees pay, not paying them is the same as keeping your employee’s funds.
A fiduciary relationship exists when the employer holds and then remits employee taxes. When the taxes are not remitted in a timely fashion, the IRS and States jump into action. The failure to pay taxes can cause the officers of a corporation to become personally liable. The officer’s personal assets and home can have a lien. Penalties for this offense can be 100% of the taxes owed so you can end up owing double the original amount.
This is just a small sampling of the types of tax mistakes that can get you audited. Often it pays to have an accountant looking proactively into your business to ensure these types of problems don’t occur. Ultimately, you bear responsibility, but having a second opinion from seasoned professional can certainly maximize your chances of getting it right.